Cash Flows: focus on costs

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Cash flow is a self-financing measure of the company whose objective is to generate liquidity that the company will use in different ways for example; current expenses and long-term investments. Cash flow is generated by the difference between cash inflow and cash outflow.

The analysis of cash flows (or Cash Flow Statement) is extremely useful for an entrepreneurial activity, as it represents the instrument of analysis and control of financial management. In other words, it helps the entrepreneur to better understand when to make an investment, to agree on the correct payment timescales with suppliers and to develop the best business strategies that allow an adequate cash inflow.
As well as the more structured sectors, such as industrial or product, also the sports sector, such as fitness centres, spas, beauty centres or sports centres in general, presupposes an excellent knowledge of the financial performance of your company. This allows the entrepreneur to knowingly answer questions such as:"In X months' time, how much money will I have on my current account?";"Do I need to negotiate with my bank a subsidised interest rate for overdraft?"; "In periods of increased liquidity, how much do I have to set aside to cover current expenses in periods of low seasonality?”

Specifically, in order to obtain reliable answers, it is necessary to develop a spreadsheet that, starting from the figures in the Balance Sheet and Income Statement, indicates the net liquidity in the current year. This value takes into account all incoming and outgoing flows that create a financial movement. In order to understand better, we take into consideration a specific cost item:"depreciation". They are shown in the Income Statement and, like other cost items, contribute to the reduction in profit for the year. Their impact on the company's economic performance is therefore negative.
They do not have the slightest impact from a financial point of view: this item represents a "cost" but not an "outflow of money". They are part of so-called "non-monetary income components". Let's assume that in year 0 I purchased a new personal computer of the latest generation for the graphic designer who takes care of the communication of my sports centre. This means that I have had a monetary outflow (financial impact). The PC is, however, a durable good and, as such, is assumed to have a life of several years. From an economic point of view, I will not charge 100% of the cost in year 0, but only a part of it (normally 20%). The remaining value will be allocated in subsequent years at the same rate. The impact on profit will therefore be reduced but constant in the following years (normally 5 total years).

While on the financial level I have a movement exclusively in year 0. When I buy the product. It is quite clear how much the analysis of a cost item in the income statement alone does not give me a true picture of the financial situation of my sports centre. On the contrary, the final values of the two instruments (profit/loss vs liquidity) are often very distant from each other. It is therefore good, during the business plan phase, not only to develop the Income Statement and Balance Sheet, but also to carry out an in-depth financial analysis.

There are also other costs that normally (except for any accruals or deferrals) are treated in the same way from an economic and financial point of view. Take, for example, travel expenses (fuel, motorway, hotel) or rents, salaries of employees and collaborators, cleaning and maintenance costs.
Finally, there are accounting movements that do not produce financial manifestation, such as the free share capital increase. In other words, it refers to accounting increases in share capital without any new income from fresh financial resources, but obtained as a different allocation of the reserves already recorded. This has no financial effect.

The more we get into the characteristics of a single sport reality, the more we discover that the generic guidelines on the development of a Financial Report that we find online or on textbooks are as useful as they are to customize and adapt to specific needs. The copy-paste will certainly produce very unreliable forecast results and, especially in the case of investment planning, also dangerous.

As a course planning can hardly be copied in a specular way between 2 different realities, so a Financial Report must be structured according to the characteristics of the sports centre under analysis. In any case, we try to provide guidelines to achieve this goal. The starting point is to have a reclassified Balance Sheet for Sources and Lending and an Income Statement reclassified to Contribution Margin.

It is important to note the behaviour of current assets (current receivables) and current liabilities (current payables). Contrary to what happens in the balance sheet, an increase in receivables makes the final result worse for me. A credit is synonymous with "liquidity to which I am entitled" but which I do not yet have at my disposal. It is money that I cannot spend yet. It is the opposite for debts: if they increase (not for a pathological situation!), I will enjoy a better financial situation. I will in fact have more liquidity at my disposal. This justifies the need to obtain longer payment times from some suppliers.

The final result of this model (total cash flow) allows me to know the change in liquidity (available cash on the company current account) compared to the previous year. This means that the Cash Flow Statement should be developed over a five-year time horizon. Or at least three years.
Attention however: the report is not a "static document": once it has been produced it will almost certainly be subject to changes over time depending on both the real trend of my business and exogenous events (opening/closing a competitor, particularly hot winter, very rainy summer, etc.). What is important is that we do not need to overturn this document. In that case, it would mean making serious errors in the forecasts which could jeopardise the soundness of my business.

It is therefore good to see the Financial Report as an important rudder that helps one's captain (the entrepreneur or the business team) to achieve a series of objectives with less difficulty. Among the main ones:

Better and more informed business management

Evidence of accurate information on cash inflows and outflows in the predefined period

Punctuality in the payment of suppliers

A management of periods characterized by low liquidity (E.g: July and August for fitness centres)

Providing a clear picture of financing and investment activities

Increased credibility by banks and investors

It is clear that it is important to analyse the finances of one's own sports centre with a serious, scrupulous and consistent approach over time. In doing so, I will be able to manage my finances correctly, thus recognising a deviation and understanding how to intervene.

We identify three types of management:

economic: through self-financing or through the resources generated by the company's economic activity quantifiable in the sum of operating profit and non-financial costs/revenues;

operational: through the management of payment terms for trade payables and receivables. In the case of debts, it is intended to agree with the other party on a new payment deadline, not to delay these timeframes without an agreement;

strategic: through investment choices in durable goods adapted to one's own business model and the procurement (and reimbursement) of internal and external sources of financing.

This management first of all allows the property to monitor the performance of the sports centre, intervening in an informed manner, and stakeholders to understand whether the company has a satisfactory state of financial health, which can be totally dissociated from the ability to achieve positive economic results.

Finally, the Cash Flow Statement can be defined as the integration of balance sheet and income statement values into a new statement that represents changes in the financial and monetary structure during the year. In the day-to-day management of the sports centre, the entrepreneur is thus helped to monitor in the best possible way:

the ability to generate positive future cash flows

the economic and financial aspects of investment and financing transactions

ability to meet maturing commitments and payment of dividends

the causes of the differences between income for the period and cash flow and payments

Previously knowing the financial potential of a business in the long term is fundamental for the success of its business.

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